This is the placeholder for the general topic of tax ownership. It won’t be that specific or that informative but will act as an orientation to the topic.
How is tax ownership different from ownership?
It’s not really different at all. I think calling it tax ownership is a bit of a misnomer. That’s simply a designation that is used to give context to the discussion. You don’t really need to be a tax lawyer to understand tax ownership concepts. You just need to be a person who knows what’s yours and what’s theirs.
Then why talk about it?
Determining tax ownership is important for determining tax consequences so long as the tax consequences of owning a thing are different from the tax consequences of owning a thing whose value is derived from a thing. For example, the tax consequences of owning a notional principal contract (commonly referred to as a swap) on X stock can be very different from actually owning the X stock, even if the economics are virtually identical. One of the differences is that a dividend on X stock can qualify for the dividend-received deduction and the qualified dividend income rate, but receiving the exact same amount on a swap does not. Therefore, as long as owning a thing and owning a derivative on a thing have different tax consequences, tax ownership will be an issue.
What are derivatives?
As far as I know, there is no single defined catch-all term “derivative” in the Internal Revenue Code. I’m sure someone can correct me if I’m wrong—assuming anyone Is reading this?
In any event, even if there was, I intend to use derivatives in its broadest sense to simply mean “something that comes from something else”. This definition is clearly broad enough to capture a whole swathe of things that are common financial derivatives: options, swaps, forwards, futures, etc.
However, in the manner I’m using it, you can also think of almost any financial instrument as a derivative, including stock, partnership interests, debt, etc. I view stock as a derivative because it derives its value from the assets of a corporation, and I view debt as a derivative because it derives its value from cash. In my mind, they are simply special types of derivatives that have their own tax treatment much like options and swaps have their own tax treatment. And just like other tax instruments, you have to think through the tax ownership issues that result from using those “derivatives”.
For example, let’s say Lt. Dunbar has an option to purchase X Company’s stock and X Company has title to Land which it rents to Stands With a Fist. Tax ownership may be relevant to determine:
- Whether Lt. Dunbar, X Company or Stands With a Fist owns the Land.
- Whether Lt. Dunbar owns X Company stock outright.
- Whether Lt. Dunbar owns an option to purchase X Company stock.
This only gets more complicated when you realize that Lt. Dunbar and Stands With a Fist might also have some sort of relationship with each other.
My thesis on tax ownership
So now that we know it’s an issue and why it’s an issue, how do I go about thinking about this? When people talk about examining the tax ownership issue, they typically refer to the “bundle of sticks” and talk about all sorts of factors when examining the tax ownership issue. A fairly common, and oft-cited, example of this is Grodt & McKay v. Comm’r, 77 T.C. 1221 (1981), which is a case that seems to involve something about cattle. Well, whatever that case is about, it went through an 8-factor test to determine ownership:
- Whether legal title passes;
- How the parties treat the transaction;
- Whether an equity interest in the property is acquired;
- Whether the contract creates a present obligation on the seller to execute and deliver a deed and a present obligation on the purchaser to make payments;
- Whether the right of possession is vested in the purchaser;
- Which party pays the property taxes;
- Which party bears the risk of loss or damage to the property; and
- Which party receives the profits from the operation and sale of the property.
However, I find jumping into these factor tests sort of the tail end of the tax ownership question rather than what’s really driving it. I personally feel that the core of tax ownership analysis revolves solely around who controls disposition of the thing. It is the dispositive fact, so to speak. Oliver Wendell Holmes, Jr. stated it much better than I could in Corliss v. Bowers, 281 U.S. 376 (1930)*:
The income that is subject to a man’s unfettered command and that he is free to enjoy at his own opinion may be taxed to him as his income, whether he sees fit to enjoy it or not. We consider the case too clear to need help from the local law of New York or from arguments based on the power of Congress to prevent escape from taxes or surtaxes by devices that easily might be applied to that end.
He talk good.
I think my thesis re: control over disposition dovetails well with what would be common notions of ownership. If I lend you my bike in return for a security deposit, I’m letting you ride it but I’m not giving you the right to dispose of it. It’s still mine. When I lend you a dollar bill, that dollar bill is yours to dispose of. Therefore, the dollar bill I loaned you is yours (you owe me a dollar back, but it would invariably be a “different” dollar bill). To me, the factors referred to above either highlight certain aspects of one party’s ability to control the subject property and/or are necessary where control over disposition is fuzzy or illusory.
So, this will be the lens through which I will look at specific case studies on tax ownership like stock loan, repo, swaps, options, etc. To the extent a case doesn’t agree with my thesis, I will try to view it objectively. That is, I will object to it.
*This is an assignment of income case which is, essentially, a case about tax ownership of income. It’s also a one-page Supreme Court decision. Man, those were the days.